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May 5, 2011RBI releases Winter 2010 Issue of its Occasional Papers

The Reserve Bank of India, today released the winter 2010 issue of its OccasionalPapers. Occasional Papers, a research journal of the Reserve Bank, contains contributionsof its staff and reflects the views of the authors. This issue is woven around some importantthemes which have been at the forefront of policy discussions. The issue contains articles,special notes and a book review.

Should Monetary Policy in India Respond to Movements in Asset Prices?

The paper Should Monetary Policy in India Respond to Movements in Asset Prices?by Bhupal Singh and Sitikantha Pattanaik examines whether monetary policy should becomemore sensitive to asset price movements and respond proactively to prevent any build up ofbubbles. The assessment is done in the backdrop of the debate stimulated by the recentsub-prime crisis. The empirical analysis in the study indicates that while interest ratechanges cause movements in stock prices, the reverse causality does not hold. Thissuggests that monetary policy in India does not respond to asset prices, but the asset pricechannel of monetary policy transmission exists. However, shocks to credit conditionsexplain a significant part of asset price variations over medium to long-run, which could be

part of a broader co-movement of variables over the business cycle, particularly real activity,credit flows and asset prices.

The authors are of the opinion that since higher interest rates seem to causecontraction in output, credit demand as well as asset prices, the impact on asset prices aloneshould not be viewed as a good enough reason to use monetary policy for stabilising assetprice cycles. Further, any policy that aims at limiting the overall pace of credit growth mayhave to be driven by developments, such as, either economic overheating or persistent highinflation, but not the perception of an asset price bubble. In their evaluation, asset pricedynamics could be difficult to decipher for a meaningful use in the conduct of monetarypolicy. The authors are of the view that financial stability concerns from asset price bubblescould be better addressed through micro and macro-prudential measures, and the

effectiveness of such measures could be enhanced when implemented in a soundmacroeconomic policy environment.

Exports and Economic Growth: An Examination of ELG Hypothesis for India

In the paper titled Exports and Economic Growth: An Examination of ELG Hypothesisfor India, Dr. Narayan Chandra Pradhan examines the nexus between export growth andeconomic growth and tests the export-led growth (ELG) hypothesis for Indian economy. Thepaper has gone beyond the traditional neo-classical theory of production function byestimating an augmented Cobb-Douglas production function covering exports includingservices exports, and has empirically examined both, short and long-run relationshipsbetween exports and growth. The study finds that about 14 per cent disequilibrium is

corrected every year in case of goods and services and GDP. This empirical findingreinforces the nexus between export and GDP growth in both, short and long run. The test ofGranger causality suggests that the direction of causality runs from export growth to GDPgrowth. On the other hand, there is no reverse causation from GDP growth to export growth.The result of Granger causality/Block Exogeneity in VAR framework can be interpreted to

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say that in the case of Indian economy, movements in the exports appear to lead those ofGDP. This implies that one can use exports as an additional variable to better predict theGDP growth thus substantiating the importance of exports in the growth process of Indianeconomy.

Special Notes

Determinants of Private Corporate Sector Investment in IndiaUnder the Special Notes section, the paper on Determinants of Private Corporate

Sector Investment in India by Ramesh Jangili and Sharad Kumar has explored thedeterminants of corporate investment in a sample of non-Government non-financial publiclimited companies operating in India. The paper spans the period 2000-01 to 2008-09. Thepaper has used the panel regression model for empirically identifying the factors whichinfluence corporate investment decisions. Specific factors, such as, firm size, dividendpayouts, leverage, cost of funds, production as well as cash flows along with the macro-economic variables like real effective exchange rate, inflation, non-food credit growth andcapital market developments are considered as endogenous variables in the model. Theresults show that firm size, cash flow ratio and growth in value of production are positively

associated, whereas, dividend payout ratio and effective cost of borrowing are negativelyassociated and are statistically significant to investment of the firm. The authors also find thatreal effective exchange rate and inflation at the macro level are negatively related with thecorporate investment and non-food credit growth and capital market developments arepositively related.

Inclusive Growth and its Regional Dimension

The study, Inclusive Growth and its Regional Dimension by P. K. Nayak, SadhanKumar Chattopadhyay, Arun Vishnu Kumar and V. Dhanya analyses the inter-linkagesbetween different development indicators and various regions and sections to understandthe nuances of Indias growth process. The authors examine the causal relationshipbetween bank finance and economic growth in a time-series framework with co-integrationand error correction model. The study finds that bank finance plays a major role in thegrowth process with bi-directional causality between GDP growth and financialdevelopment. The impulse response function analysis indicated that the impact of credit onGDP is stronger than the reverse. In conclusion the authors emphasise the role of financialinstitutions in the overall scheme of inclusive growth. The study concludes that furtheranceof macroeconomic reforms, harnessing synergistic links among the sectors, opportunitiesprovided by the forces of globalisation and intensive use of technology could lead toachieving higher level of inclusive growth.

Book Review

P.S. Rawat reviews the book titled Asia and the Global Economic Crisis:

Challenges in a Financially Integrated World by John Malcolm Dowling and PradumnaBickram Rana, Palgrave-Macmillan, 2010.

The book, with twelve chapters, elaborately covers the origin of global economiccrisis and deals with the responses of the US and Europe and quickly moves on tofocussing on its spread to Asia, especially Asias reaction/policy responses to it. The bookanalyses the impact of the policy responses and the persisting challenges in rebalancingthe global economy, the next steps in regional economic integration in Asia, and issuesrelated to reform of the international financial architecture. As the world is emerging fromthe crisis, the book assesses what has been achieved so far, where Asia stands at thebeginning of the new decade and what more needs to be done to successfully managefinancial globalisation in the future.

Alpana KillawalaPress Release : 2010-2011/1617 Chief General Manager